Written by Jeffrey Cammack: Published: August 28, 2016
January 12, 2016, marked the peak of the USD/ZAR exchange rate, which was the culmination of a well-defined bullish trend that started in the summer of 2011, and has now been on a decline ever since. There are several macro catalysts that have caused this – from the US Federal Reserve’s unwillingness to hike rates for a decade, China’s slowdown, decreasing commodity prices, and South Africa internal political affairs.
Negative Interest Rates Policy versus SA Monetary Policy Tightening
There are disparities in economic policy between developed economies and emerging markets, such as South Africa. On the one hand, the developed world is pursuing strong easing of monetary policies, with many countries intensifying their easing efforts and introducing negative interest rates policies, (NIRP) while South Africa has stepped up tightening efforts with two rates hikes since the beginning of the year pushing the benchmark interest rates from 6.2% to 7%.
South Africa is more prone to financial instability due to the relationships it has with the major central banks that are now collectively adjusting their policies, encouraging risk-taking and seeing capital flows exaggerated into and out of the emerging economies.
As the opportunity to make a return on investment in an NRIP environment is so low, investors have been motivated to take on risk in favor of higher returns offered by emerging markets countries like South Africa. However, as the increase in volatility and risk becomes more apparent, there is an exaggerated outflow of capital from South Africa.
Commodity Price Rally
It comes as no surprise that commodity prices have dramatically surged, especially the metals if you take into consideration the NIRP and the global uncertainty of Brexit. Gold has started a cyclical recovery that will prevent the Rand from weakening too much. Since South Africa is a major commodity exporting economy, this puts the USD/ZAR exchange rate at risk to any fluctuation in Gold prices. Since the beginning of the year, Gold prices rallied 24.37% making it among one of the best-performing assets in 2016. This, in part, explains why the Rand has been so strong thus far in 2016.
South Africa Domestic Economy
South Africa reclaimed its status as the largest African economy toppling Nigeria in August 2016, which held this position for more than two years. South Africa’s GDP growth was also influenced by the increase in the exchange rate value of the ZAR, which gained +12.77% this period, making it the second best performing emerging market currency after Russian Ruble. The size of the South African GDP at the current exchange rate is $301 billion. However, in real terms, the GDP growth rate contracted in the first quarter of 2016 by 1.2% annualized rate.
Foreign investors would like to see a more balanced political environment in South Africa. The saga surrounding South Africa’s Finance Ministers started with the Nenegate scandal and more recently with Pravin Gordhan, the new Finance Minister, has failed to induce any material effect on the currency exchange rate. Since the Nenegate scandal, the ZAR has been strengthening. The Rand only showed temporary weakness in response to the most recent comments from the Fed Chairwomen Janet Yellen, which sparked speculation of a possible second USA rate hike sooner rather than later.
The interest rate differential is heavily in favor of the Rand, so without any major political moves, the exchange rate will continue to do well as the political landscape hasn’t had any major material impact on the USD/ZAR exchange rate.